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Abstract
A great deal of attention has been given in recent years to the question of externalities
associated with water entitlements and how third parties can be protected without
restricting opportunities for water trade. Yet one market failure that has received no
attention at all is the missing market for storage that arises from the specification of
water entitlements, particularly in Victoria where historically all storage decisions
were made at the centralised level and where any additional carryover was treated as
common property. The economic significance of the missing market for storage is
demonstrated using an empirical model that represents the spatial-temporal pattern of
irrigation water demand in the Goulburn Valley and decisions regarding inter-year
storage of water in Lake Eildon. It is shown that, because irrigators have no incentive
to trade-off the benefit of current use (or sale) with the value of water storage, there is
an erosion of reliability when opportunities for trade are broadened. The empirical
results demonstrate that the loss in economic value associated with reduced reliability
are as large as the gains from trade, so there is no net benefit from trade.